Overcoming Obstacles

to Agricultural Microfinance:
Looking at Broader Issues

Gilberto M. Llanto
Philippine Institute for Development Studies, Philippines
Email: gllanto@gmail.com

Abstract

This paper presents a general picture of the difficulties in developing a sustainable lending service
geared toward smallholder agriculture. Drawing on the experiences of the Philippines and other
countries, it traces the rethinking of the agricultural credit policy following the collapse of subsidized
agricultural credit programs, and the subsequent rise of microfinance, as pioneered by nongovernmental
organizations. Acknowledging that the main challenge is not about the straightforward application of
microfinance technologies to agriculture, the paper discusses how crafting an approach to sustainable
agriculture microfinance is influenced by myriad of issues.
The paper concludes that overcoming the barriers to agricultural microfinance goes beyond the
simple provision of credit, extends outside agriculture, and shuns a “one size fits all” approach. To be
able to deal with the complexity and risks in agriculture, rural lenders would have to innovate on their
product design, lending technologies and risk management strategies; improve their information base;
and strive to have access to market-based risk management products. Moreover, policymakers have
to recognize and understand the peculiarities of the rural and agriculture sector, namely: information
asymmetry, geographic dispersion, heterogeneity of the population, covariant risks, insecure property
rights, and the absence of insurance markets and risk-reducing institutions.

INTRODUCTION populated urban areas in East Asia and Southeast

This paper provides an overview of some of
the main obstacles to agricultural microfinance
and draws attention to certain issues that have to
be considered in crafting a strategy to overcome
perceived obstacles. At the onset, it is good to
delimit the discussion into the financing problem
faced by smallholder agriculture, more particularly
rural farming households. This is because there is
relatively very limited formal lending to smallholder
agriculture while commercial agriculture is able to
tap commercial loans from both private commercial
banks and government banks.
The rise of microfinance in the last 20 years
has unlocked the puzzle of how to profitably lend
to the poor and the micro-enterprises in densely
Asia. Similar early experimentations with providing
micro-loans to Latin American micro-enterprises,
as pioneered by international non-government
organizations, have metamorphosed into formal
lending by local non-government organizations
(NGOs) and banks to thousands upon thousands
of urban micro-entrepreneurs.
Among such banks, as listed by Christen
and Pearce (2005), are: specialized banks such
as Mibanco in Peru and K-REP Bank in Kenya,
many of them with NGO origins and strong
social mission; the mainstream banks for which
microfinance is one of several lines of business,
such as Banco Caja Social in Colombia and Banco
de Pichincha in Ecuador; and the state-owned
development banks for which microfinance is
24 Asian Journal of Agriculture and Development, Vol. 4, No. 2
a public mandate, like Bank Rakyat Indonesia
and Banco do Nordeste Brazil. The Asian region
has some of the more successful micro-lenders
such as the Association for Social Advancement
(ASA) and the Grameen Bank in Bangladesh; the
Thaneakea Phum in Cambodia; the PT Ukabima
in Indonesia; the Center for Agriculture and Rural
Development (CARD) Bank, CARD NGO, Alalay
sa Kaunlaran, Inc. (ASKI), Taytay sa Kauswagan
(TSKI), and National Women for Tomorrow
Foundation (NWTF) in the Philippines; and many
others which have implemented successful urban-
based microfinance.
The challenge, however, is how to harness
microfinance lending technologies to finance
smallholder agriculture.
Put another way, what lessons in microfinance
can be utilized to develop a sustainable lending
service catering to smallholder agriculture? 1 What
policy, regulatory or institutional issues could inform
attempts to develop agricultural microfinance as a
strategy for providing sustainable finance services
to smallholder agriculture? Is our understanding
of the risks and the particular conditions inherent
in agriculture adequate to inform an intelligent
discourse on microfinance as (possibly) applied to
agriculture? Can microfinance, therefore, address
the lack of accessibility of agriculture-based
households to credit and other financial products?
The difficult task of answering these questions
will take the concerted effort of policymakers,
microfinance practitioners, and regulators.
These issues have been tackled by various
works, among them, a seminal paper by Christen
and Pearce (2005) on managing risks and designing
products for agricultural microfinance, various
papers presented at a 2003 conference on rural
finance in Washington, D.C., a recent review of
rural finance in the Philippines by Llanto (2005),
and the reports in the MicroBanking Bulletin. This
paper does not pretend to present solutions, much
less an in-depth analysis of those issues and lessons.
It has the more modest objective of presenting an
overview of those issues, pointing out potential
pathways for crafting a strategy or an approach to
sustainable agricultural microfinance, and hopefully
sparking a vigorous discussion that would propel
the progress of agricultural microfinance.
1
From hereon, the terms “agriculture” and “smallholder agriculture” are used interchangeably.
PAST FINANCING ATTEMPTS
THROUGH SUBSIDIZED
AGRICULTURAL CREDIT
In a study of rural financial markets conducted
for the Asian Development Bank, Meyer and
Nagarajan (2003) pointed out the major contrast
between, on the one hand, the rapid transformation
of the rural economy, made possible by exceptional
technological change and an economic revolution
that raised agricultural productivity and, on the
other, the stagnation in rural financial markets.
Government investments in irrigation, roads
and power have helped to create markets for the
expanding farm production.
The rise in agricultural productivity has raised
farm and non-farm income and allowed the region
to largely escape the problem of widespread
hunger. Summarizing the findings of Rosegrant
and Hazell (1999) and other researchers, Meyer and
Nagarajan (2003) pointed out the significant rural
transformation in Asia in the past three decades,
identifying technological change, improved rural
infrastructure, and policies that did not discriminate
against agriculture as the factors that paved the way
for a productivity revolution, thereby significantly
increasing agricultural output and efficiency.
On the other hand, the economies that promoted
massive state intervention, had weak infrastructure,
and pursued more inward- than outward-looking
policies, were least successful in achieving an
agricultural revolution to stimulate a broader
economic transformation.
The rapid structural transformation has
been marked by the decline in the relative size
of agriculture in Asian countries. The share of
agriculture value added in total gross domestic
product in the Republic of Korea fell from 34
percent in 1966 to about 6.5 percent in 1995
(Rosegrant and Hazell 1999).
In the same period, agriculture’s share fell
dramatically from 51 to 17 percent in Indonesia,
from 33 to 11 percent in Thailand, and from 28 to 13
percent in Malaysia. In slower-growing countries,
the declines were from 45 to 28 percent in India, 37
to 26 percent in Pakistan, and 26 to 22 percent in
the Philippines. There has also been a significant
decline in agricultural labor relative to the total labor

force. The agricultural labor share in the Republic
of Korea fell from 54 percent in 1966 to 14 percent
in 1995, and that in Malaysia from 58 to 23 percent
in the same period. In 1995, the agricultural labor
share in Indonesia, Pakistan, the Philippines, and
Sri Lanka was relatively high at approximately 40
to 50 percent. It was 60 to 70 percent in Bangladesh,
People’s Republic of China, India, and Thailand,
and over 70 percent in Myanmar and Nepal (Meyer
and Nagarajan 2003).
A significant phenomenon of the transformation
of the rural economy is the rise in non-farm
activities. Rosegrant and Hazell (1999) observed
that rural non-farm activities in Asia accounted for
40 to 60 percent of total national employment and
20 to 50 percent of total rural employment. Survey
data indicate the large contribution of non-farm
activities, e.g., food processing, and weaving, to
rural household income.
Rural landless or near-landless households earn
wage income from non-farm activities during off-
peak farm seasons. Rural structural transformation
has led to the commercialization of agriculture as
economies, which took advantage of the Green
Revolution technologies and provided the enabling
environment for markets to function, including
adopting policies that did not discriminate against
agriculture, realized marketable surplus directed to
both the rural and urban economy. A key insight
is that the commercialization of agriculture and
the transformation of the economy as a whole
happened in market economies with varying
degrees of efficiency. Some economies, however,
are experiencing difficulties in creating markets
and supportive institutions, thus constraining
agriculture’s contribution to economic growth
(Meyer and Nagarajan 2003).
On the other hand, the same study of Meyer
and Nagarajan characterized Asian financial
markets as “struggling”. These authors said that
the “undeniable conclusion of this study” is that
the rural financial markets in Asia are “ill-prepared
for the twenty-first century”. The authors blamed
heavy government intervention in the rural financial
markets through subsidized credit programs and
the use of specialized government development
finance institutions to finance the policy goals of
governments, e.g., the support to Green Revolution,
as factors that weakened rural financial systems.
Gilberto M. Llanto 25
The motivation for such intervention was the desire
of governments and donors for farmers to adopt
Green Revolution technologies, among others.
The common belief then was that unless small
farmers had access to funds at “more reasonable
interest rates than available from informal sources”,
the opportunities for productivity brought about
by Green Revolution technologies would remain
untapped. These views provided the justification
to develop targeted and subsidized agricultural
credit programs along with other interventions
affecting input and output markets. Thus, countries
created subsidized credit programs to induce
the rapid adoption of the new technology (e.g.,
seeds, fertilizer and chemicals for production) and
generally to address the lack of access to formal
credit by small borrowers.
The Bimas project in Indonesia and the
Masagana 99 in the Philippines were examples of
this strategy. Through these projects, the Indonesian
and Philippine governments, respectively, provided
highly subsidized loans to farmers who agreed to
adopt the new technologies designed to increase
farm productivity. In Latin America throughout the
decade of the 1980s and until they liberalized their
financial sectors in the 1990s, Guatemala, Peru and
Bolivia implemented subsidized credit programs,
targeting specific sectors of their respective
economies in an attempt to provide these sectors
access to credit. They used government banks like
agriculture development banks to provide credit
at highly subsidized lending rates, often using
government resources as the source of loan funds
(Llanto 1999).
A great number of subsidized agricultural credit
programs have collapsed in both Asia and Latin
America. In the case of the three Latin American
countries mentioned above, the government banks
that were used to channel subsidized credit to target
clientele were unable to sustain financial losses
brought about by the non-repayment of loans and
had to close down. The infusion of artificially cheap
credit weakened banking systems, imposed huge
fiscal burdens on governments, and eroded the
financial discipline of rural borrowers. Soon, the
sheer weight of unpaid loans and the fiscal costs of
subsidized loans made governments rethink their
rural credit policies and strategies. Subsidized
credit programs went bust when funds stopped
26 Asian Journal of Agriculture and Development, Vol. 4, No. 2
flowing as governments felt the enormous strain
of financing those unsustainable credit programs.
Thus, a serious rethinking of agricultural credit
policy followed in many countries.
In the wake of governments’ costly adventure
in the wonderland of directed (targeted) and
subsidized credit programs is a landscape littered
with the remnants of a weakened rural financial
system and small rural borrowers who continue
to depend on informal credit for the liquidity to
finance consumption and investment requirements.
Governments expecting to wean small borrowers
away from moneylenders found that their basic
instrument, that is, credit subsidy, was not only
a costly intervention but also an ineffectual tool.
Meyer and Nagarajan observed that the existence
of subsidized credit institutions discouraged the
emergence of market-based institutions in rural
areas and contributed to the disparity between
households and firms that gained access to formal
finance and those that were denied access.
At the height of Masagana 99 in the Philippines,
there were more than 1,000 rural banks, many of
which participated in the subsidized credit programs
but this peak number eventually tapered to only
about 600. A large number had to be closed down
or rehabilitated while those that survived had to be
rehabilitated or strengthened through an infusion
of new money, a restructuring of their debt with
the government, and painstaking capacity-building
efforts.
Multilateral donors, which used to be the
biggest source of agricultural finance, have
reduced their support for agricultural credit
financing. Christen and Pearce (2005) reported
that agricultural loans accounted for 31% of
World Bank lending in 1979-81, but by 2000-
01 those loans had fallen to less than 10%. This
drop was partly due to a disappointment with the
unsatisfactory performance of large agricultural
finance projects and partly to the fact that World
Bank rural finance had been increasingly extended
to other areas through microfinance projects or as
part of community development, infrastructure,
or rural development projects. Lending by other
multilateral development banks and bilateral aid
agencies mirrored this trend.
At the Inter-American Development Bank,
total lending to agricultural credit projects under
the category “global agricultural credit” fell from
US$1.6 billion between 1986 and 1990 to no lending
at all in the period 1991-1995. Notably, multilateral
funding shifted from agricultural credit projects
that addressed narrow agricultural development
objectives to projects involving microfinance,
more integrated community development, and
infrastructure or rural development, thereby
reflecting the grave concern of governments and
donors alike about the persistence of the problem of
global poverty. Thus, when donors and governments
started to consider a more comprehensive strategy
of nudging forward rural development, agricultural
credit projects had to give way to community-wide
development projects that were seen as providing a
more suitable platform for poverty reduction. The
achievement of the Millennium Development Goals
became a key component of the poverty reduction
strategy, and donor funding followed suit.
It seems that the stagnation of rural financial
markets may partly be because of distortions brought
about by government intervention in the credit
markets. It is equally noted that notwithstanding
the heavy government intervention in rural
financial markets, many rural borrowers continue
to rely on informal lenders such as traders, input
suppliers, professional moneylenders and even self-
finance. Understandably, traditional banks have
shied away from agriculture because the risks in
agriculture—arising from climatic conditions, pest
infestation, plant diseases, calamities like flooding
and drought brought on by both natural and man-
made causes—have not been properly understood
and managed. Thus, informal lenders with a better
understanding and information about the rural and
agricultural environment continued to hold sway
over small borrowers. Market and price risks that
are exacerbated by information asymmetry and
poor information infrastructure have also deterred
formal lending. Subsidized agricultural credit
programs were thought to be the solution but their
loan repayment performance turned out to be
dismal. Moreover, they were costly to maintain and
proved to be unsustainable, forcing governments,
which also had to address the requirements of other
sectors of the economy, to rethink their rural credit
policy and programs. While government economic
policies may be biased against agriculture and may
cause significant harm to agricultural producers,
international market conditions are also a source
of risks for those producers. Christen and Pearce

(2005) cited the recent entry of Vietnam into the
coffee industry as an example of the impact of
changing international market conditions on a
country’s credit markets. The success of its coffee
producers came at the expense of higher cost coffee
producers and banks in Latin America. Commercial
banks that specialized in lending to small coffee
producers throughout Central America carried the
burden of millions of dollars of bad debt in their
portfolios. Whoever said that agricultural finance
was easy?
THE RISE OF MICROFINANCE
While governments were devising new
strategies to provide financing to smallholder
agriculture and address the perennial problem of lack
of accessibility of formal credit, non- governmental
organizations (NGOs) were busy providing micro-
loans to poor women and micro-enterprises that
have been ignored by the banking system. NGOs
in Bangladesh and Latin America provided micro-
loans to small borrowers and recovered the loans,
with profits to show. In Latin America, NGOs and
banks using their own micro-lending techniques
led the way in providing micro-loans to thousands
upon thousands of small borrowers. Some of
these were MIBANCO in Peru, Banco Solidario in
Bolivia and GENESIS Empresarial in Guatemala.
In Asia, the Grameen bank approach of providing
micro-loans to groups of poor women without
collateral and heavy documentation soon became
a mainstream micro-lending technique used by
hundreds of NGOs and even small banks to reach
small borrowers, typically, micro-entrepreneurs
and poor rural households. The successful Grameen
bank experience is well-documented and it will
not be necessary to expound on it in this paper.
The Association for Social Advancement (ASA)
improved the Grameen micro-lending technique
and showed that with a much simpler and cost-
effective approach, credit services could be
provided to much more small borrowers than could
be reached by using the older Grameen approach.
The ASA micro-lending technique is simpler
to administer and exploits the small borrowers’
preference for individual loans over group loans.
ASA realized that group members eventually
renege on their individual loans because of the
cross-guarantee requirement of a typical group
Gilberto M. Llanto 27
loan. They would rather get individual loans and be
wholly responsible for repaying those loans (Table
1).
The traditional formal banking system and
costly directed and subsidized credit programs have
both failed to provide small-scale borrowers with
access to loans and other finance services. This has
motivated credit-granting NGOs to take the lead in
developing and evolving various micro-financing
techniques that could effectively reach the poor on
a sustained basis. Microfinance institutions (MFIs)
such as credit-granting NGOs provide micro or
small loans without collateral at market rates of
interest to small-scale clientele, mostly non-farm
enterprises and micro-enterprises. Typically, the
MFIs’ familiarity with the borrowers and the local
economy enables it to extend loans based on the
borrowers’ cash flow and to tailor-fit the loan
repayment in accordance with that cash flow. They
require the simplest procedures for documentation,
lending, loan collection, and monitoring. They
liberally use a variety of instruments to create
incentives to repay the loan, such as peer pressure,
joint liability groups to ensure borrower discipline,
rewards to motivate the good behavior of clients
and loan officers, and threat of cancellation of
future loans for defaulting borrowers, among others
(Llanto 1999).
The good news is that the dynamic microfinance
markets are coming up with a wide range of
financial products and services that are demand-
responsive (Table 2).
In recent years, MFIs have changed their focus
from providing a simple credit product to offering a
full array of financial services, and from targeting
micro-enterprises to reaching the broader market
of low-income households with varying business
and family needs. The increased remittance from
overseas workers has triggered the demand for
efficient money transfer mechanisms. Thus, the
range of MFI products and services may include
savings, credit, insurance, and payment products
such as money transfers (Rhyne and Otero 2006).
CARD Mutual Benefit Association (MBA) became
a provider of micro-insurance products, e.g., life and
accident insurance for poor households, in response
to the demand for those products by those ignored
by mainstream commercial insurance providers.
Life cycle products in the taxonomy provided
by Rhyne and Otero are in demand: education
28 Asian Journal of Agriculture and Development, Vol. 4, No. 2

Table 1. Grameen Bank Approach vs. Association for Social Advancement Method.

Grameen Bank ASA Method

Origin In 1976 Bangladeshi Professor ASA Bangladesh was organized in 1978 as an

Muhammad Yunus launched the NGO. It decided to specialize in credit delivery
“Grameen Bank Project,” which was for the poor in 1991.
authorized as a bank in 1983.
Special features Unlike the conventional banks, the Operation costs are minimal because of
Grameen provides collateral-free loans standardized accounting and bookkeeping
to poor women, delivers service to the procedures, and a simple branch structure,
people, pays attention to the welfare of with a manager and four loan officers. The
the borrowers’ families, and enforces no model is simple and easily replicable.
legal instrument to recover the loan.
First introduced GBA replication started in 1990 through ASA methodology was first introduced to the
in the Philippines the “Grameen Bank Replication Program” Philippines in 1999 through the UNDP-funded
(1990-1997) of the Agricultural Credit “Microfinance Support Project” (1999-2002).
Policy Council.
Target clientele Women from low-income households The poor, landless laborers and marginal
or the “poorest of the poor” farmers, especially poor rural women.
Types of service Financing several income-generating Simple loan and savings products. (“Single
activities, including education, housing, product service”)
seasonal and sanitation activities.
Place of services Direct delivery to the community. Direct delivery to the community.
Lending style 1. Organize groups of 5 persons and Micro-loans
federate 5-8 such groups into a center. 1. Organize groups of 10-30
(The sizes of groups and centers like-minded women.
are variable.) 2. Members give contribution called capital
2. Stagger loan releases to group buildup (CBU) for 4 consecutive weeks prior
members in a 2-2-1 or 3-2 manner. to release of first loan.
3. Give credit in small or variable sizes. 3. Within 5-6 months all group members receive
4. Loans are for 6-12 months. loans, with a possible increase depending on
5. Give progressively bigger amounts the needs and demonstrated competence.
for repeat loans. 4. The loan amount may increase per year
6. Require weekly meetings of group depending on the client’s need and
centers attended by the MFI’s competence.
field staff: Center leaders and members Small business loans
perform loan appraisal and the staff Available for men and women with a
verify information and make periodic demonstrated competence in business.
visits to client businesses.
Training Training for group members to ensure For the first 1-2 months: training in group
credit discipline. management, leadership and other themes.
Repayment Group guarantee (Use group solidarity No group liability. Past due loans are considered
responsibility and peer pressure to ensure repayment). an individual’s obligations. Group members
For matured centers with high portfolio are required to come to a designated collection
quality, meetings are held monthly center weekly at a specific time to make their
instead of weekly. repayments and deposit their savings.
Repayment In weekly installments for a term of 1 year In weekly installments. Delinquency controlled
method or less. by sit-down or doorstep technique by loan
officers. (“Zero-tolerance”)
Compulsory Compulsory weekly savings or a Mandatory weekly Capital Buildup (CBU) for all
Savings percentage of the loan that is types of loan products; and voluntary savings.
deducted at the time of disbursement/ Allow members to withdraw savings, provided
repayment to set up center and/or 10% of the loan disbursed remains in the
individual fund for emergency. account.
Other features Relaxed savings withdrawal policy Introduced life insurance in 1993 for borrowers
in late 1990s to let the members of of up to 55 years of age. Opened up savings
10 years or more transfer savings facilities for non-loanees in the late 1990s.
from group fund to a separate
individual account.
 Gilberto M. Llanto 29

Table 2. MFI product range.

Financial product/services Examples of MFIs offering product/service

Home improvement Micasa loan product of Mibanco in Peru is

highly successful and growing.
New home purchase BancoSol (Bolivia) and Banco Solidario (Ecuador) offer
mortgages to the upper tier of their clientele.
Education Uganda Microfinance Ltd. provides school
fee loans; Equity Bank in Kenya extends loans to
schools.
Consumer Banco Azteca, Mexico provides loans to consumers
buying appliances from Elektra stores.
Working capital All MFIs provide this.
Credit life, whole life insurance CARD Mutual Benefit Association (Philippines) and
MUSSCO (Malawi) have pioneered in micro-insurance.
Health insurance SEWA Bank (India) and AssEF (Benin) are strong
providers of health insurance.

Source: MicroBanking Bulletin (2006).

savings accounts, loans for home improvement, requirements of agriculture-based households,

and pensions. To be counted also are products and
services such as leasing, crop insurance, and money
management products such as bills payment and
remittances.
The bad news is that despite the growing
commercialization of microfinance and the
emergence of new finance products, with banks and
various types of financial intermediaries joining the
bandwagon, the asset side of the balance sheet of
those microfinance institutions (MFIs) is composed
mostly of micro-credits, that is, short-term loans
for micro-enterprises, designed for urban-based
borrowers with predictable cash flows, e.g., petty
traders, vendors, food processors and others. Ryhne
and Otero (2006) note the difficulty of delivering
the ideal product array described above, which
would require MFIs to change, for instance, the
financial strategy and business model that have
been used to provide simple micro-loans. Thus,
micro-loans have remained as the staple product
of many microfinance institutions.
Microfinance was initiated in densely populated
urban settings in response to the demand for micro-
loans with short maturities, which were needed
for the liquidity requirements or relatively rapid
turnover of micro-businesses such as food vending;
borrowers here have usually diversified income
sources. The question that arises is whether it is
possible to apply the effective lending techniques
of urban-bred microfinance to the financing
which are chiefly engaged in the typical seasonal
farm-based activities, with risks far different
from those faced by urban households. Some
credit cooperatives/unions in Latin America and
village banks, e.g., in Cambodia, have maintained
successful agricultural lending programs. However,
they are limited in scale.
A potential point of entry for microfinance is
the reality that many Asian rural households are
engaged in both farm and non-farm activities. But
as noted by Gonzalez-Vega (2003), agricultural
microfinance will require an understanding of the
information, incentives and contract enforcement
in a different type of setting. It will have to contend
with not only a wide geographical dispersion of a
heterogeneous population, but also the attendant
covariant risks and many other concerns, which
should motivate efforts to innovate in response to
those challenges (Buchenau 2003).
SOME KEY ISSUES
IN AGRICULTURAL MICROFINANCE
The issue at hand is not about the
straightforward application of microfinance
technologies to agriculture in order to provide
small farmers and other agriculture-based economic
agents with access to sustainable finance services.
The case at hand is much more complex and
challenging than can be imagined. Christen and
30 Asian Journal of Agriculture and Development, Vol. 4, No. 2
Pearce (2005) have documented the problems
faced by lending institutions in the agriculture
sector. In Uganda a bumper maize harvest in late
2001 and early 2002 caused maize prices (and
farmer incomes) to fall, significantly affecting
loan repayment in four branches of the Centenary
Rural Development Bank. In Mali, Kafo Jiginew,
a federation of credit unions suffered a deteriorated
portfolio at risk (over 90 days) from 3% of the total
in 1998 to 12% in 1999 due to a slump in cotton
prices. Cotton loans had a very a large share of the
credit union’s loan portfolio.
It is, thus, necessary to have a keen understanding
of (a) agricultural conditions, (b) the configuration
of risks in the rural areas, the availability of risk-
mitigation instruments and how to use those
instruments, and (c) the incentives that will affect
the design of the finance (loan) product, including
mechanisms for recovery—in the case of a loan
product, the loan recovery methods. These issues
can be largely understood in terms of three
significant characteristics of rural credit markets
identified by Besley (1994), which shape the nature
of appropriate credit policy and program responses,
namely: 1) the scarcity of collateral, 2) the absence
of complementary institutions to reduce risks, and
3) covariant risks and market segmentation.2
Scarcity of Collateral
Traditional collateral may be scarce because
borrowers may be too poor to have significant assets
that can be pledged as collateral. The scarcity of
collateral may also be attributed to the relatively
small sizes of farm lands and the lack of secure
titles to those small pieces of land. In the case of the
Philippines, the fragmentation of farm lands and the
demise of land markets because of agrarian reform
have imposed an additional constraint (Estanislao
and Llanto 1995; David et al. 2003; and Llanto
and Ballesteros 2002). Certain provisions of the
Comprehensive Agrarian Reform Law such as:
(a) the prohibition against mortgaging/selling of
the land within 10 years of its award and upon full
payment by farmer- beneficiaries to the Land Bank
2
See Besley (1994). To these three characteristics may be added the following: information asymmetry, uncertainty and
seasonality of agricultural activities, greater heterogeneity and dispersion of clientele, greater exposure to systemic risks,
the small size of transactions, and the absence of standardized and documented information, which have effectively deterred
commercial-bank lending.
of the Philippines; (b) the setting of a ceiling on the
ownership of agricultural lands at five hectares;
(c) the designation of government as the sole
buyer of awarded lands; and (d) the prohibition
against share-tenancy arrangements, have eroded
the collateral value of land. This has hampered
the small farmer’s access to credit in the formal
financial markets.
The World Bank’s Land Administration and
Management Project (LAMP) in Thailand and
the Philippines underscores the severity of land
titling and administration problems in the two
countries, particularly in the rural areas of the latter
country. Llanto and Magno (2002) note that the
inefficient land administration system has resulted
in high transaction costs in securing, registering
and transferring property rights. There is no
efficient mechanism to resolve land disputes, and
the land administration system does not generate
the reliable information needed by the courts to
hear land cases. Also, the high cost of registering
land discourages registration and consequently
investments on land. Poor land administration can
erode public confidence and trust in the titling and
land registration system, and this puts especially
the poor at a great disadvantage.
Secure property rights, which are a fundamental
requirement for a collateral-oriented banking
system, may be poorly developed or even absent.
Of course, MFIs have long ago shown that micro-
enterprise loans, including loans to poor individuals
(mostly women), do not necessarily require the
traditional land collateral as security. MFIs have
lent to asset-less individuals and have successfully
recovered the loans. However, one may argue that
the context of urban micro-lending is quite different
from that of rural and agri-based lending, where
borrowers may demand bigger and longer-term
loans. The size of the loan may be larger and the
loan maturities are typically longer than the usual
micro-loans that have to be repaid within a 90-day
period in view of the rural borrower’s different
consumption and investment requirements. Both
rural borrowers and lenders face the challenge
of discovering alternative mechanisms such as

contractual arrangements, contract farming and
others, viewing rural households as integrated
business and family units with multiple sources of
income, and adjusting loan repayment schedules
to the households’ cash flow and to the agriculture
cycle.
Thus, rural lenders have to adopt a “business
unusual” approach and innovate because the
constraint imposed on rural credit markets by the
“scarcity of collateral” seems to be a myth. Christen
and Pearce (2003) gave the example of Banco del
Estado de Chile, which spent two years improving
its micro-enterprise lending techniques before
expanding into farming activities. It also improved
agricultural finance techniques, for example, by
integrating crop-based analysis into its wider client
analysis and by having flexible loan repayment
schedules based on seasonal income cycles. The
Economic Credit Institution, a microfinance
institution in Bosnia and Herzegovina, uses
spreadsheets for key agricultural products compiled
by an agronomist as an aid to cash-flow analysis.
Risks, Risks and More Risks
Skees (2003), Ibarra (2003), Bryla (2003),
and Christen and Pearce (2005) provide a neat
summary explanation of the risk issues faced by
rural borrowers such as small farmers and their
rational behavior toward risks. Bryla cites a 1999
World Bank study showing how price volatility
significantly impacts on the incomes of farmers
and the macroeconomic health of their countries.
From 1983 to 1998, the prices of many commodities
fluctuated from below 50 percent to above 150
percent of their average prices. Facing a spectrum
of risks, the most frequently cited of which are
price, weather and health risks, farmers respond
by adopting low-risk and low-yield crop and
production patterns to ensure a minimum income
at the expense of rural growth and accumulation of
capital. Alternatively, in the absence of insurance
markets, farmers try to cope with price and other
risks by: (a) asset accumulation, savings, and
access to credit; (b) income diversification; and
(c) informal insurance arrangements. Ibarra (2003)
views the increased labor market participation
by small farmers, the reduction of consumption,
the resort to interest-free loans or donations from
relatives and friends, and the sale of assets such
Gilberto M. Llanto 31
as livestock, as risk-coping strategies, and not
risk management strategies.
Successful agricultural microfinance as
indicated by the experience of Banco del Estado
de Chile is about pooling and managing risk.
But how well can rural lenders cope with the
correlated risks in agriculture? Traditional
agriculture loans portfolios, especially those
of government banks or development finance
institutions, show a concentration of production
loans to certain crops, e.g., rice, maize, cocoa,
and livestock. The concentration of production
loans creates concentrated risks for the rural
lending institution. There seems to be no major
problem if the risks involved are individual
and are not correlated. However, the reality
is that risks in agriculture are correlated.
When agricultural commodity prices decline,
everyone faces a lower price for their crops.
Natural disasters such as widespread flooding
that destroy crops, livestock, shelter and rural
infrastructure, severely impact rural households
in many contiguous areas.3 Price and yield
risks are spatially correlated and this poses a
major challenge to agricultural microfinance.
On their own, small rural lenders, e.g., rural
banks, cooperatives or credit-granting NGOs,
are simply not capable of pooling and managing
correlated risks. Worse, they may have no
experience whatsoever in dealing with these
different types of risks. Because of this, many
rural lenders, which may have experienced the
adverse effects of correlated risks in agriculture
on their loan portfolios or which may be aware
of the negative experience of other lenders in
this regard, would tend to avoid agricultural
Referring to the problems faced by agricultural microfinance
3
in Bangladesh, Md. Shafiqual Haque Choudhury, President
of the Association for Social Advancement (Bangladesh),
has identified flooding as a critical problem because of
the extensive damage wrought on the crops. He cited the
vulnerability of farmers to this disaster, especially when
it hits just before harvest season, laying their already
mature crops to waste and plunging them into a severe
crisis. Mr. Choudhury further observed that: “Sometimes
it is found that the floodwater remains stagnant for a long
period. Although it makes the land fertile with alluvial soil, it
causes loss to the peasants by delaying cultivation”.(These
remarks were made during the International Workshop on
“Overcoming Obstacles to Agricultural Microfinance”, held
at Heritage Hotel, Pasay City, March 1-2, 2007).
32 Asian Journal of Agriculture and Development, Vol. 4, No. 2

lending or drastically limit their loan exposure
to smallholder agriculture.
Anecdotal evidence from the author’s
interviews with rural bankers in Mindanao,
Philippines shows that the wary rural lenders
have nonetheless practiced rational decision-
making through loan diversification to minimize
credit risks. This is evident, for instance, in their
moves to cap their agricultural lending, shift their
target clientele to teachers and other government
employees who they provided with salary loans, and
focus on urban micro-lending. In Latin America,
diversification is one of the primary risk-mitigation
strategies of rural lenders. The MFIs tend to limit
agricultural lending to less than one third of their
portfolios, e.g., about 25% of the portfolio for
Confianza (a rural finance institution in Peru),
but only 6% for Bolivia’s Caja Los Andes, with a
similar level for Uganda’s Centenary Bank. Some
Latin American MFIs, e.g., PRODEM of Bolivia
and Calpia of El Salvador do not lend to rural
households without non-farm income or those
dependent only on one or two crops, as a strategy to
contain risks in agricultural microfinance (Christen
and Pearce 2005). Box 1 is an illustration of the
experience of a Latin American financial institution
with concentration and diversification in the loan
portfolio.
Observing local rural economies, Vogel and
Llanto (2005) pointed out that there seems to be
a parallel diversification of risks among rural
households—mirroring a risk management strategy
as opposed to an ex post coping strategy such as
liquidation of households assets in response to, say,
a catastrophe like flooding that wipes out standing
crops. Rural households have tried to diversify their
risks through family members engaging in non-farm
activities. Rural income still largely comes from
farm production, although income from non-farm
activities is becoming significant in Asian countries,
as pointed out earlier. Philippine data show that in
1987, on-farm income contributed 56 percent to
total rural income, while off-farm income’s share
was 7 percent. This means that 63 percent of the
rural income came from both on-farm production
and off- farm activities, e.g., livelihood projects.
By 1990, farm incomes (on-farm and off-farm
incomes) had declined to 57 percent while income
from non-farm and other sources has increased to 43
percent (Agricultural Credit Policy Council, 1992).
Incomes from non-farm activities and other sources
such as remittances have become a significant
source of rural incomes.
Remittances from overseas Filipino workers
(OFWs) and relatives based abroad have also
become an increasingly important source of income

Box 1. Peru, Caja Rural San Martin: Diversifying its loan portfolio

Between 1994 and 2000, more than half of Caja Rural San Martin’s portfolio was mostly agriculture loans
to small- and medium-size rice farmers. But in 1998-99, Peru’s rice crop was severely damaged by the
El Niño phenomenon. Heavy losses in crop yields caused a steep rise in prices that attracted many new
producers, resulting in overproduction and sending rice prices to an all-time low. Then in 2000-01, a
plague destroyed the rice crop for many of the bank’s clients. At the same time, Alberto Fujimori’s regime
introduced populist policies promoting debt forgiveness and restricting banks from imposing further loan
recovery measures on delinquent farmers. All these events caused a severe decline in the quality of Caja
Rural San Martin’s loan portfolio.

The events of 1998-2001 forced the bank to become more risk-averse and diversify its loan portfolio.
After nearly halving new agricultural loans in 2001, the bank later discontinued lending for rice production
altogether. Since 2002 it has provided loans only to farmers who have well-established farm enterprises,
own irrigated land and can provide land and chattel guarantees. The bank now has a diversified loan
portfolio, with micro-enterprise, housing and consumer loans, in addition to agriculture loans.

Portfolio quality has improved as a result, and Caja Rural San Martin is now less vulnerable to production
and price risks. By November 2002, its outstanding loan portfolio was US$ 16.3 million, with more than
13,000 borrowers and a portfolio at risk at 8% (with payments more than 30 days overdue).

Source: Rubio (2002a) as cited in Christen and Pearce (2003)


for many rural households. They contributed 32
percent of the total income generated within the
period 1991-2000 and helped keep the economy
afloat. With the decline in incomes from agriculture
and agriculture-related activities, remittances
have become an alternative and significant source
of income for rural families. Although a large
number of OFWs are from urbanized areas,
such as the National Capital Region (NCR) and
Southern Tagalog, many of them also come from
mainly agricultural regions with high poverty
levels. Some families depend entirely on these
remittances as their main source of income while
others have used a portion of these funds to pursue
informal lending activities that provide external
financing to farmers and entrepreneurs. Thus, these
remittances either directly or indirectly provide
the rural areas with the necessary liquidity that
formal institutions cannot supply. The significant
increase of overseas remittances has contributed
to the growth of business and economic activities
in the rural areas.
In sum, it is important for formal rural lenders
to be equipped with accurate information on the
agricultural crop cycle; the pattern of risks; how
rural households earn, spend, save and borrow
money; what risk management and risk-coping
strategies and instruments are used by those
households; the variety of farm and non-farm
activities; and attempts to diversify local economies,
among others. In short, rural lenders must have a
thorough understanding of their potential clients
and the milieu or context of their daily lives and
economic and business activities.
The challenge of Liquidity Management4
The main unrecognized challenge in rural
finance is the problem of overcoming the systemic
risks arising from the undiversified nature of local
economies. Notwithstanding the diversification
efforts of small-scale farmers and most other
rural residents, especially low-income ones, rural
areas themselves remain largely undiversified
4
This section draws from Vogel and Llanto (2005).
5
Officials at the government-owned Quedan Rural Credit and Guarantee Corporation (Quedancor) stated that their institution
had developed a service of buying problem loans from rural banks, which could potentially be targeted toward providing this
needed liquidity service. However, this is not the kind of liquidity service contemplated by this paper.
liquidity of the kind discussed in the paper is different from the illiquidity problem of insolvent rural banks. Some rural banks
may be illiquid simply because they can not recover their loans; in this case, the “service” being developed by Quedancor
may create the wrong incentives.
Gilberto M. Llanto 33
economies. In fact, the typically undiversified
nature of rural areas presents a major challenge
to most rural residents – even shopkeepers in a
rural town will be adversely affected if the major
product (e.g., rice) suffers a decline in price or loss
of output due to adverse weather or insect pests.
Thus, a rural lender does not escape this lack of
diversification by lending to shopkeepers rather
than to farmers. In finance, risks are dealt with
by portfolio diversification, but for a local lender
the opportunities for loan portfolio diversification
are sharply limited, so the lender is likely to be
left with the alternative of holding relatively large
amounts of liquid assets and thereby curtailing
local lending. Realizing the absence of effective
demand, one type of lender would decide to park
the excess liquidity in commercial papers, bills and
securities, e.g., government bonds and securities.
On the other hand, there is the lender who has
lending opportunities but is pressed with temporary
lack of liquidity and has to abandon the likelihood
of lending.
In the Philippines, there is no institution
dedicated to providing a much-needed liquidity
service, i.e., providing short-term loans to rural
lenders that are temporarily short of liquidity
but fully solvent in the longer run if the liquidity
problem can be overcome. Rural banks can
potentially access liquidity from the Bangko Sentral
ng Pilipinas (BSP), but conditions surrounding
access are appropriately rather draconian, based on
the usually correct assumption that lack of liquidity
indicates potential insolvency. Government
financial institutions such as the Land Bank of
the Philippines or the Development Bank of the
Philippines or a federation of credit cooperatives
could perhaps fulfill the function of providing
liquidity to local lenders with temporary liquidity
problems, but in general, government entities
and cooperative federations do not exhibit the
appropriate degree of toughness in separating
temporary liquidity shortages from pending
insolvency.5 An obvious solution to this problem of
systemic risks in local areas could be to rely more
The issue of temporary
34 Asian Journal of Agriculture and Development, Vol. 4, No. 2
heavily on nationwide financial institutions (e.g.,
large banks) to provide most rural loans. However,
recent experience in the Philippines shows that even
slightly adverse financial conditions could trigger
a reduction in rural lending by commercial and
universal banks. Clearly, these banks view rural
lending as a relatively risky undertaking – not unlike
most banks worldwide that have failed to develop
effective mechanisms to delegate lending decisions
adequately to small branches while maintaining
appropriate systems of internal audit and financial
controls.6
Absence of Risk-reducing Institution
As pointed out earlier, risks are correlated
in agriculture, and this can potentially ruin a
rural lender who does not have an effective risk
management strategy and who may not have
access to risk-reducing instruments or institutions.
Insurance markets are important institutions for
overcoming systemic risks but complementary
institutions, such as insurance markets and credit
information bureaus, that may help to reduce
those risks may be lacking or underdeveloped in
developing countries in Asia.
The absence of such risk-reducing mechanisms
to manage correlated risk and insulate lenders
from its adverse impact constrains agricultural
microfinance (Skees 2003; Ibarra 2003; Bryla
2003).
In this regard, a comment on the performance
of the Philippine crop insurance is in order. Where
crop insurance has been implemented, the costs
have typically been extremely high, in part because
of the difficulties of administering large numbers
of small contracts spread over wide areas, but more
often because of problems of adverse selection
and moral hazard (Vogel and Llanto 2005). The
experience of the Philippine Crop Insurance
Corporation (PCIC) can be seen in this light.
The number of farmers covered by crop
insurance exhibited a declining trend from 108,512
in 1995 down to 54,093 in 2004. At the peak of its
operation in 1991, the PCIC provided some 336,000
6
Some exceptions are the Bank Rakyat Indonesia Unit Desa system, and most notably, the recently rehabilitated and privatized
Agricultural Bank in Mongolia which has been able to expand simultaneously its branch network and its profitability while
reducing both administrative costs and overdue loans.
7
See Bryla (2003); Skees (2003).
farmers with rice and corn insurance amounting to
over 3 billion pesos and covering more than half a
million hectares of land. Crop insurance coverage
has since declined. Crop insurance coverage
for the period 1995-2004 exhibited a declining
trend although it showed improvement toward the
later years. Insurance coverage decreased by 18
percent during the period 1997-1998. It improved
only slightly in 1999 by 1.6 percent, but this was
negated by a decrease of 1.3 percent in 2000. The
largest decrease happened in 2001 when insurance
coverage dropped by 31.5 percent from P1,274
million in 2000 to P874 million. The government’s
crop insurance scheme was simply no match to
covariant risks. There is insufficient diversity in
the “risk pool” to deal with covariant risks. Brazil,
India and Morocco also have crop insurance
schemes but the overall verdict, it seems, is that
crop insurance schemes failed because of moral
hazard and adverse selection problems and high
transaction costs.
Systemic risks brought about by insufficient
diversification in local rural economies, changing
weather patterns, seasonality of supply, and
fluctuations in global markets have discouraged not
only private investments but also the participation
of private banks in agriculture finance. Both crop
insurance and credit guarantee schemes have failed
to expand private bank lending to agriculture. A
better package of risk-reducing instruments could
consist of the following: efficient infrastructure,
access to technology and information, credible
regulatory regimes, and recently developed market-
based instruments designed to address price- and
weather-related risks.
The problem of correlated risks is not insolvable.
Innovations in global financial markets, which can
deal with correlated risk and reduce the rural lenders’
exposure to local risks, e.g., drought, have been
developed.7 These are the futures exchange markets
to shift price risk; and weather-based, index-based
insurance products to shift natural disaster risk.
Price risk management instruments tacked in loan
agreements can lower default risks arising from
falling commodity prices. An example of such

price risk management instrument is a put option,
a hedging instrument for price risk. A simple put
option may be purchased at international exchanges.
Combined with physical sales, it will guarantee
a minimum price level based on an international
price for a given commodity over a number of
months. When price rises during the option contract
period, the producer receives no payout from the
contract but can still sell his physical product at
the prevailing market price. In this situation, the
producer benefits from rising prices. When price
falls during the option contract period, the producer
receives a payout equal to the difference between
the price the producer chose to insure with the put
option contract and the international market price on
the last date of the option coverage. The problem
faced by the small producer may not necessarily
be the market-based premium paid for such price
risk management instrument but access to the
international exchanges.
On the other hand, weather risks are covariant
and typically shock entire regions and entire farming
communities at one and the same time. Weather-
based index insurance has been developed as a
risk management instrument. Under this scheme,
a farmer can insulate himself from production risk
by purchasing an index insurance that pays in case
rainfall falls below a certain threshold. Farmers
can elect coverage for a given period, taking into
consideration the crop cycle. Farmers who have
bought such an index insurance receive a payment if
the rainfall index level falls below an agreed rainfall
threshold. The farmer receives more protection the
higher is the rainfall threshold but this is bought at
a higher premium. A farmer wishing to minimize
the cost to him of this index insurance may go for
a lower rainfall threshold but at the price of lower
protection. He, thus, has to evaluate the trade-off
and make a decision.
Missing Opportunities
in the Agriculture Supply Chain
Understanding the agriculture supply chain
may create profitable opportunities in agricultural
microfinance for rural-based economic agents.
Research (Boehlje, Hofing and Schroeder, 1999a;
199b) on value chain in agriculture indicates that
21st century agriculture is likely to be characterized
by: 1) adoption of manufacturing processes in
Gilberto M. Llanto 35
production as well as processing, 2) a systems
or food supply chain approach to production and
distribution, 3) negotiated coordination replacing
market coordination of the system, 4) a more
important role for information, knowledge and
other soft assets (in contrast to hard assets of
machinery, equipment, facilities) in reducing cost
and increasing responsiveness, and 5) increasing
consolidation at all levels raising issues of market
power and control.
As the raw produce goes through each link of
the chain, it undergoes varying degrees of value
adding, such as processing and packaging, before
it is distributed to consumers, thus ultimately
increasing the original value of the good. The
supply chain can also be loosely referred to as a
value chain. The added valuation to a raw product is
a result of the increasing stratification in consumer
tastes and the need to be more efficient, which is
an offshoot of competition in global markets. The
agriculture supply chain offers scope for small
farmers to participate but they have to deal with
the problem of aggregation of the produce from a
large number of small farmers and the associated
distribution and marketing of the accumulated bulk
product.
According to Kaplinsky (2000), the importance
of the value chain lies in the concept that the chain
is a repository for economic rents, i.e., each link in
the chain carries a premium from which profits can
be made. Increasingly, primary economic rents in
the chain of production are to be found in the areas
outside of production.
Globalization has highlighted the need for
an effectively functioning supply chain to meet
diverse consumer needs. As world markets
converge, inefficient local agricultural producers
are pitted against competitive producers in the
global arena. Due to insufficient capital, inadequate
infrastructure, and weak institutions, small farmers
and other rural producers in developing countries
may find it quite a challenge to cope with the
demands of global markets for competitively priced
goods and commodities (Van Roekel, Willems, and
Boselie 2002). Local producers sometimes find it
hard to match the significantly lower production
costs and lower transport and handling expenses of
other countries. Consequently, the cost of domestic
goods, which is already higher relative to those
from other countries due to higher input costs, is
36 Asian Journal of Agriculture and Development, Vol. 4, No. 2
further driven up by high processing, marketing,
and distribution costs.
One of the most important links in the value
chain is the provision of transport and storage
facilities. It links primary producers to processors
and packagers and finally to marketing and
distribution units for the consumption of end-users.
Costales and Macapanpan (2004) stressed the need
for transportation and storage systems as important
factors of productivity and competitiveness in
agro-industry. There is therefore a very great need
for an efficient transport infrastructure, which
includes road, ship and air transport, and adequate
storage capacity. Rural linkage with domestic and
global markets depends to a great extent on the
availability, quality, and location of transport and
storage systems, which will help dispersed rural
communities to overcome their isolation. framework.
Understanding the great potential of supply
chains will enable rural producers/clients to position
themselves strategically in the different subsystems
of these chains. Subsystems in the agriculture
supply chain have their respective value-added
activities and banks could provide financial services
for those value-adding activities.8
In crafting appropriate responses, policymakers
should learn lessons from the prominent role
played by traders in the supply chain and rural
financing systems. Traders act as moneylenders
at the start of the cropping season and as buyers
during the harvest season. They are available to
rural borrowers at the time and place where their
help is needed. Their access to rural information
brought about by close association to rural clients
and their keen understanding of rural networks and
economies have served them well in plying their
loan products (based on simple, timely, accessible,
and flexible loan terms) and in creating interlinked
contracts. Traders may act as independent buyers
of local produce or as middlemen between major
integrators, wholesalers or processors and farm
producers. In any of these major roles, they add
value and provide timely financing that otherwise
would not be provided by formal financial
institutions. Government-directed credit programs
have found it very difficult to compete with the
8
Discussions with Pablito Villegas, former Vice-President, Land Bank of the Philippines.
9
This section draws on Llanto (2006b).
10
Llanto (2006b) discusses these issues in detail.
interlinked contracts, timely access to financing,
and storage and transport facilities that traders have
effectively provided to rural-based clients for many,
many years.
Regulation and Supervision Issues9
Microfinance has developed and expanded
generally because of the permissive (within bounds)
attitude of the regulators, who are aware of the vital
task of finding an appropriate regulatory framework
for microfinance. The pioneering efforts of the
Philippine central bank to develop such framework
can be cited. The Philippine Congress recently
revised the General Banking Act, which recognized
the peculiar nature of microfinance and tasked the
central bank to develop an appropriate regulatory
Regulators in many developing countries seem
to recognize that microfinance promises to be a
sustainable mechanism for providing financial
services to poor households and micro-enterprises.
However, there should be prudence in the way a
regulatory framework is crafted and in the manner
of supervising banks engaged in microfinance.
As stressed by Valenzuela and Young (1999),
regulation that comes too early can hamper
innovation in financial service and institutional
forms. On the other hand, an overly strict approach
would suffocate innovative microfinance practices.
In general, regulatory authorities are still developing
an understanding of the microfinance phenomenon,
making sincere attempts to flesh out an appropriate
regulatory framework, and building the required
capacity for effective supervision (Llanto 2006)10.
The same observations may be said of agricultural
microfinance. Regulators should bear in mind
that the timing of the introduction of regulation
is important (Christen and Rosenberg 2000) and
that microfinance cannot be simply placed in the
category of conventional credit categories, that is,
consumer loan, commercial loan or mortgage credit
(Jansson 2001).
The key challenge is finding the appropriate
regulatory framework for agricultural microfinance
which would recognize the different risks faced

by rural lenders (that is, the regulated lenders such
as banks) and which would ensure the soundness
of those rural lending institutions, including the
protection of deposits. Recent literature shows that
poor rural households and micro-enterprises demand
different types of financial services and products,
including savings deposits with (regulated) banks.
Successful methods for delivering financial
products and services to poor households and
micro-enterprises have grown and matured outside
conventional banking and conventional regulatory
frameworks. The Holy Grail of regulation and
supervision is developing an appropriate regulatory
framework that ensures the soundness of financial
institutions and protects depositors without
dampening innovative impulses.
Fine-tuning existing regulatory frameworks
may not be sufficient. On the contrary, it may
create a false sense of complacency on the part of
tradition-minded regulators that all is well with the
approach when in reality the innovative financial
impulses that are so important in microfinance and
in this case, the more challenging phenomenon of
agriculture microfinance, are either constrained or
dampened.
Van Greuning et al. (1998) point out that
the approaches to regulation and supervision
of microfinance can range from “non-existent”
to “full regulation,” either through the existing
prudential regulatory framework or by modifying
the existing regulatory requirements to fit the
organizational and operating characteristics of
microfinance institutions. Such retrofitting of
traditional regulatory frameworks should be taken
with great caution.
In contrast to this approach is risk-based
supervision, a relatively new approach to supervising
regulated financial institutions, which is preferable
to traditional bank supervision (Vogel et al. 2000).
Under risk-based supervision, most financial
products and services share a common set of risk
factors but can have very different risk profiles.
The difference lies in the risk profiles and not in
the set of risk factors (Vogel et al. 2000). Thus,
risk-based supervision concentrates on the lending
institution’s ability to manage risks and not on the
collateral required to secure the loan, nor on the
number of unsecured loans, nor compliance with
tedious documentation, and other factors that are
Gilberto M. Llanto 37
the concerns of traditional bank supervision. The
innovative approach taken by the Philippine central
bank in supervising microfinance banks is shown
in Box 2.
In sum, the “jury is still out,” so to speak, on
the search for an appropriate regulatory framework
or approach for microfinance. There is no one-
size-fits-all approach to regulation and supervision
but on balance, the rationale and arguments for
risk-based supervision seem to outweigh those
favoring more traditional approaches. Designing
regulatory mechanisms and building effective
institutional frameworks are never easy tasks, but
these may be facilitated by a constant dialogue and
interaction between regulators and microfinance
institutions and other types of (regulated) financial
institutions.
CONCLUDING REMARKS:
INNOVATING FOR THE FUTURE
The strategies and solutions to overcome the
barriers to agricultural microfinance go beyond
the simple provision of credit, and extend outside
agriculture. There is no “one size fits all” approach
to agriculture microfinance. To be able to deal
with the complexity and risks in agriculture, rural
lenders would have to innovate on their product
design, lending technologies and risk management
Box 2: Risk-based supervision of
microfinance banks, Philippines
Under the traditional supervision of banks,
the bank examiners look at the individual
books of accounts and try to trace the
transactions since the last examination up to
the current examination date. Under risk-based
supervision, before the examiner leaves the
central bank, he pre-evaluates credit risks of
the bank, and market, liquidity, operational and
compliance risks. The pre-evaluation enables
the examiner to pinpoint which of those risks
are very high. This is the area of focus during
the field examination. This approach and the
awareness of the bank’s portfolio at risk have
reduced the number of examination days from
30 (under the traditional approach) to 15 days
or less (under risk-based supervision).
Source: Bank examiner of the Bangko Sentral ng
Pilipinas.
38 Asian Journal of Agriculture and Development, Vol. 4, No. 2
strategies; improve their information base; and strive
to have access to market-based risk management
products, e.g., price risk management instruments,
weather-based index insurance contracts and
similar products. They would have to discover the
right approach that will satisfy their risk-return
appetites and innovate to be able to adapt to the
characteristics of the agriculture sector, particularly,
smallholder agriculture.
Tasked with crafting an environment conducive
to rural lending and to meeting the demand of
rural-based economic agents for other finance
services, policymakers have to recognize and
understand the peculiarities of the rural and
agriculture sector, namely: information asymmetry,
geographic dispersion, heterogeneity of the
population, covariant risks, insecure property
rights, and the absence of insurance markets and
risk-reducing institutions. While the policy and
regulatory environment must be able to motivate
experimentations and innovations, great care should
be taken by the authorities to ensure the stability
of the rural financial system. There is promise
in further developing risk-based supervision in
view of the discussion of risks facing agriculture
microfinance. This is to say that policymakers
should not only invest in the necessary information
infrastructure (e.g., a credit bureau to break down
information asymmetries), and allow market-based
mechanisms to address risk problems, but also
provide the hard infrastructure, e.g., roads, water
and other basic necessities, that will set the platform
for the growth of the rural economy.
AUTHOR’S NOTE
This paper was presented at the International
Workshop on “Overcoming Obstacles to Agricultural
Microfinance”, organized by SEARCA and CARD
MRI, and held at the Heritage Hotel, Pasay City,
March 1-2, 2007.
REFERENCES
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